Deflation, Inflation, and Hyperinflation
First off a few definitions from Wikipedia:
Deflation is a decrease in prices of goods and services. Deflation occurs when the annual
inflation rate falls below 0%.
Inflation is an increase in prices of goods and services. Inflation occurs when the annual
inflation rate is above 0%.
Disinflation is a decline in the inflation rate.
Hyperinflation: is inflation that is very high or “out of control” a condition in which prices
increase rapidly as a currency loses its value. Hyperinflation becomes visible when there is an
unchecked increase in the money supply or a debasement of coinage usually accompanied by a
widespread unwillingness to hold the money for more than the time needed to trade it for
something tangible to avoid further loss. Hyperinflation is often associated with wars,
economic depressions and political or social upheavals.
The Current Situation:
Now that we are on the same page in regards to the definitions I will bring you up to speed on
where things stand in regards to our current economic situation.
We are teetering on the knife edge and not a butter knife but more the razor sharp edge of a
good chef’s knife. On one side is deflation which would be good for savers, and those who
invest in fixed income or live on one. When prices go down your dollars can by more. The
problem becomes that people will tend to hold onto their cash waiting for prices to fall further.
A good comparison is Christmas when everyone wants a bigger sale and a bigger coupon and
then when you go to by there is nothing left on the shelves since the store only had a few of the
heavily discounted item because they wanted you in the store where you might buy a heavily
marked up item. The difference is in a deflationary environment it is hard for companies to
make a profit since they have to keep cutting prices and eventually they go out of business
resulting in fewer goods on the shelves.
On the other side, the Federal Reserve wants inflation. It reduces the cost of debt as the
amount of debt held declines in value as inflation occurs. They also have no policy weapons
that are effective in a deflationary environment but they do have policy maneuvers they can
use to affect inflation.
No one wants hyperinflation. Think of Germany before World War II or more recently
Zimbabwe where they introduced the 100 billion dollar bill.
Part of the recent rush of people to invest in Gold is fear of a
debasement of the dollar leading to high inflation or hyperinflation. A recent quote I saw on
the TV is:
October 6, 2010 Hedge fund manager Kyle Bass on CNBC: he warns that in the event of
hyperinflation, it's meaningless if your stocks go up. Zimbabwe's stock market had an amazing
decade and you'd have still lost all your money.
Where to invest:
So in a high inflation environment you want to own productive assets and items that maintain
their value. Productive Assets would include farmland, timber, mines, and factories. Items that
maintain value are real estate, precious metals, and collectible artworks. You do not want to
hold bonds and other fixed income investments except in the shortest duration possible.
How it works in the real world:
Let’s take a present moment real world situation to illustrate how you as a consumer suffer in
an inflationary environment with stagnant wages and a Zero Interest Rate Policy (ZIRP) of the
Federal Reserve. Take the Cheeseburger and how it is rapidly getting more expensive to eat
one.
Meat prices have currently have rallied up 14% this year with expectations that prices will
continue to rise. The amount of cattle is already the smallest since 1973 and pork producing
hogs are near their lowest level on record. Next year, Beef supplies are projected to be the
lowest since 1952 and pork supplies at their lowest since 1976.
We will now switch to grains the main feedstock for cattle and hogs. Drought in Russia and
declining yield in America from weather issues and flooding in Pakistan earlier this year have
sent the prices soaring on a basket of agricultural goods such as Wheat-60+%, Corn, Coffee-45%
and Sugar-24%.
Now back to our hamburger: The meat has gone up in price and so has the bun. The food the
milk cow eats to make the cheese is more expensive to feed to the cow so your cheese price is
going up along with the ketchup since it contains either sugar or more likely high fructose corn
syrup. Your lettuce and onions or mushrooms (if you went for the mushroom and Swiss cheese
burger) are also increasing as the decline in the value of the dollar driven by talk of the Federal
Reserve printing money with Qualitative Easing 2 (QE2) has driven the value of the dollar down
and the price of oil back up to $84.00 and climbing. So your vegetables and everything else has
higher shipping costs. The end result is much pricier cheeseburger.
The End Result:
The final insult, especially to those receiving Social Security or a Pension with a cost of living
adjustment, is that Food and Energy are not included in the calculation of core inflation since
they are too volatile. Thanks to ZIRP your Fixed Income interest has gone down and your life
expenses are going up. The only apparent solution is to take more risk in your portfolio. This is
what the Federal Reserve wants savers to do. They want the consumer to put their money to
work in capital formation and growth. The problem they are dealing with is that the consumers
and savers are not stupid. They see the train wreck that is the housing market and the fraud
that is enveloping the foreclosure system. They see the unemployment numbers of 9.5% to
17.2%. They see a record number of people on food stamps. They see an administration in
Washington D.C. that for all intents and purposes is anti-business. They see outrageous
spending and waste and evasion of the rule of law. The consumers and savers are deciding to
save up for a rainy day or they are paying off their debts. They are investing in the one thing
they are sure of – themselves. They are working hard to make sure they keep their job if they
have one. They are cutting back on non-essentials and saving up to buy the essential goods and
services they need. There is the occasional splurge eating out or consumer good purchased but
the overall trend is towards a frugal expenditure of their money.